Why Bitcoin Prices Are Rising So Quickly – And Will Keep Going

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[Update: The positive comments about Bitcoin from numerous federal officials at Monday's Senate hearing, in addition to a letter from Fed Chairman Ben Bernanke to the Homeland Security Committee saying that Bitcoins "may hold long-term promise," caused the digital currency to spike briefly to $900 Monday evening. As of Tuesday morning, however, Bitcoin prices on Mt. Gox had settled back to about $650.]

Anyone wondering why Bitcoin prices are rising need look no further than China.

Since the beginning of November, a massive spike in Chinese buying of the digital currency has almost single-handedly caused Bitcoin prices to triple.

When you look at the numbers, it's almost surreal.

At the start of November, one Bitcoin was worth about $213 on Japan-based Mt. Gox, the world's second-largest Bitcoin exchange. Today (Monday) one Bitcoin traded as high as $675.

Volume on BTC China, where Chinese yuan can be exchanged for Bitcoins, has risen 10-fold in just over a month. Volume jumped from 2,000 to 5,000 Bitcoins traded per day as recently as September to 40,000 to 60,000 Bitcoins traded per day in the past few weeks.

The spike has made BTC China the world's largest Bitcoin exchange by volume, surpassing Mt. Gox, which allows Bitcoin trades in U.S. dollars, euros, and more than a dozen other world currencies.
The sudden surge in Chinese interest in Bitcoin – mostly as buyers – is the primary reason why Bitcoin prices are rising so rapidly.

With the total number of Bitcoins in existence having just crossed the 12 million mark, that means the total value of the currency has soared from about $2.5 billion to about $8 billion in less than three weeks.

While some have dismissed Bitcoin as a fad, the virtual currency has slowly gained traction since its inception by an anonymous creator named Satoshi Nakamoto in 2008.

In the past couple of years, more and more businesses around the world, particularly in Europe, have begun to accept Bitcoin as a form of payment.

In fact, one of the events that triggered Chinese interest in Bitcoin was in late October when Baidu Inc. (Nasdaq ADR: BIDU), a search engine company even more dominant in China than Google Inc. (Nasdaq: GOOG) is in the United States, announced it would take Bitcoin.

But it was a much more dramatic development that sent Chinese in far larger numbers to the BTC China exchange…

Why Bitcoin Prices Are Rising in China

In a very rare move, the Chinese government seems to be actually encouraging its citizens to invest in Bitcoin.

This is one of the most glaring oddities about the popularity of Bitcoin in China, as the Chinese government is not known for allowing rogue economic activity that it cannot control. But the government has done nothing to curb the Bitcoin craze.

In fact, shortly after Baidu made its October announcement, the official state television network CCTV broadcast an extremely favorable 30-minute documentary on the digital currency. And it's probably not a coincidence that the People's Daily newspaper published a positive story on Bitcoin at about the same time.

It's possible that Beijing sees Bitcoin – an international online currency beyond the control of any central bank – as a way to indirectly poke a few holes in the dominance of the U.S. dollar.

"China realizes that the yuan has to clear a lot of hurdles before it can become a reserve currency. If people start using and holding more Bitcoins in place of the dollar, it would likely lead to a less U.S.-centric global economy and that's what China wants," Kyle Drake, founder of CoinPunk, an open-source hybrid web wallet, told CNBC.

Regardless of Beijing's motives, the double-barreled stamp of approval from the Chinese government sent the populace scurrying to buy as much Bitcoin as they could.

But that still leaves the question: Why? What do the Chinese love about Bitcoin?

Based on the huge discrepancy between the supply of bitcoin (which is algorithmically regulated) and the demand (China, institutional and private investors, etc), some have predicted that the price of Bitcoin will increase to between $500,000 and $5,000,000 per unit within a three-year time frame. Whether this will happen or not, only time will tell. But what its telling us now is that Bitcoin has already increased 50x over the last 12 month.

If the Chinese have been pushing for a replacement for the dollar for some time now. They have spoken about their for a SDR type currency. Could they think BitCoin could be a part of that, or even part of a commodity-basket backed currency?

It's hard to say what the Chinese are thinking. At present, the Bitcoin market is too small for such purposes (the total value of all Bitcoin right now is only about $8 billion). However, if Bitcoin values keep rising as some predict to $10,000, $100,000 or beyond, that could change. In the meantime, the Beijing probably will keep encouraging the use of Bitcoin because it offers an alternative to the U.S. dollar for international transactions. As such, Bitcoin can incrementally lower the dollar's status and fulfill a goal of the Chinese government.

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